M&A Hotline
March 13, 2025
The Fast and the Unfair: Front-Running's Grip on
India's Capital Market
Front-running is an
unfair trading practice where traders exploit
non-public information to place trades ahead
of large orders, affecting market integrity. The Securities and
Exchange Board of India (SEBI) prohibits front
running under the Prohibition of Fraudulent
and Unfair Trade Practices relating to Securities
Market (PFUTP) Regulations, 2003, imposing heavy
penalties and potential criminal action. While both involve
misuse of non-public information, insider trading
is based on confidential company information,
whereas front-running is based on knowledge
of impending market transactions. SEBI actively investigates
and penalizes front-running cases to maintain
transparency and protect investor interests.
Introduction
‘Front running’ is the practice of
exploiting non-public information to gain an unfair
advantage in executing trades ahead of other market
participants.1 A person who is in possession
of non-public information about a large order in
respect of a security (that is likely to affect
a stock's price), utilizes such non-public information
to gain an advantage by executing certain trade(s)
ahead of those (proposed) orders, thereby benefitting
from the resulting price movement. This practice
undermines market integrity and fairness by exploiting
information asymmetry for personal gain.
Large investors or institutional investors often
place sizable orders that can influence stock prices.
Insiders or brokers who are aware of these trades
may buy scrips before executing the client's order.
When the client's order causes the stock price to
move, the insider sells their shares at a profit,
exploiting their privileged position.
In a circular issued by the Securities and Exchange
Board of India (“SEBI”)
dated May 25, 20122, SEBI has defined “front
running as usage of non-public information to directly
or indirectly, buy or sell securities or enter into
options or futures contracts, in advance of a substantial
order, on an impending transaction, in the same
or related securities or futures or options contracts,
in anticipation that when
the information becomes public;
the price of such securities or contracts may change;”
which has also been used in several orders issued
by SEBI.
The erstwhile SEBI (Settlement of Administrative
and Civil Proceedings) Regulations, 2014 also laid
down an identical explanation for the term front
running as defined under the SEBI circular dated
May 25, 20123
In addition, the SEBI (Prohibition of Fraudulent
and Unfair Trade Practices relating to Securities
Market) Regulations, 20034 (“PFUTP
Regulations”), similar to the aforementioned
definition, prohibit various fraudulent and unfair
practices, including market manipulation, insider
trading, and deceptive transactions through Regulation
4(2)(q) — “any order in securities
placed by a person, while directly or indirectly
in possession of information that is not publicly
available, regarding a substantial impending
transaction in that securities, its underlying securities
or its derivative;”.
According to SEBI, the below three ingredients
for a front running case are5:
(a) The alleged frontrunner
possesses material non-public information;
(b) Such information
pertains to a substantial transaction; and
(c) The order is executed
in advance of the consummation of said substantial
transaction.
An intriguing question that often comes up is “how
is front running different from insider trading?”
While both front-running and insider trading relate
to the use of non-public information for personal
gains, they differ in their nature and the relationships
involved.
Differences and Overlaps between
Insider Trading and Front Running
The main difference between front running and
insider trading lies in information source. A
classic example of front running is when a broker
or trader uses their knowledge of pending client
orders to trade ahead of those orders, thereby taking
advantage of the client. The key aspect of front-running
is the breach of fiduciary duty, where the broker,
acting in a fiduciary capacity, prioritizes their
own interests over their client’s. This malpractice
exploits the trust placed by the client in the broker
to act in their best interests.
On the other hand, insider trading involves trading
based on material, non-public information about
a company. This typically involves individuals who
have privileged access to confidential information,
such as company insiders, executives, or consultants,
i.e., ‘Connected Person’6.
The primary distinction here is the misuse of insider
information of the company that is not available
to the public, rather than an information relating
to a substantial order relating to a security.
Any person, whether (a) an insider exploiting ‘unpublished
price sensitive information’7 (“UPSI”);
or (b) a person undertaking the activity of ‘front
running’ by exploiting information that is
not publicly available, both challenge market integrity
and exploit information asymmetry but differ in
the source and details of the concerned information.
Despite the demarcation between insider trading
and front running and due to a lack of clear legal
provisions identifying front running, there exists
an overlap in some instances. When the source of
the UPSI stems from a company insider's actions,
leading to an external entity front-running a large
order that that is based on such UPSI. This could
cause price fluctuations and generate profits for
the outside entity, such cases can be recognized
as involving both front-running and insider trading.
For instance, an employee of a publicly traded
company becomes aware of an upcoming acquisition
by such publicly traded company of another company,
which is expected to increase the publicly traded
company’s share price upon announcement, this
information is inherently price sensitive in nature
and would constitute as confidential insider information.
In a case where such employee shares this insider
information with family members, who then purchase
shares of the company before the acquisition is
publicly announced, it would be constituted as insider
trading, as they are trading based on the unpublished
price sensitive information, i.e., the insider information.
At the same time, the employee also communicates
the insider information to a large institutional
client who agrees to place a substantial order for
the company’s stock. The client, in turn,
colludes with another market participant who front
runs the client’s trade, anticipating a price
increase once the large client order is executed.
This scenario illustrates how insider trading and
front running can occur simultaneously.
Relevant Jurisprudence
SEBI has tested this definition in certain scenarios
of front running in the recent years. In the
SEBI vs. Kanaiyalal Baldevbhai Patel8
case, the Hon’ble Supreme Court of India delivered
a landmark judgment that expanded the interpretation
of fraudulent activities in the securities market,
focusing on front-running. The Court emphasized
a broad interpretation of “fraud” under
the PFUTP Regulations, recognizing front-running
as a fraudulent practice under Regulation 4(2)(q).
It identified various forms, including trading based
on non-public information about impending transactions
and intermediaries trading ahead of client orders.
The judgment clarified that SEBI's proceedings require
proof based on a preponderance of probability rather
than beyond a reasonable doubt, allowing inferences
from circumstantial evidence and trading patterns.
As per this order, it was held that inferential
conclusion from the proved and admitted facts shall
be permitted and legally justified so long as the
same are reasonable and can be legitimately arrived
at on a consideration of the totality of the materials.
This decision reinforced SEBI's authority to curb
manipulative practices and protect market integrity.
The next question that arose with respect to
the applicability of Regulation 4(2)(q) was with
respect to the determining threshold of the term “substantial”.
In this regard, SEBI observed that there cannot
be a straitjacket formula to ascertain whether an
order is substantial in nature or not. There will
need to be a metric to take into account several
factors, as may be applicable to each subjective
order, such as liquidity in the stock, prevalent
economic conditions as well as general trends in
the stock market at that point.9 Subsequently,
in February 2023, SEBI applied the “reasonable
person” test to determine the interpretation
of the term “substantial” wherein the
judgement of a reasonable person related to the
volatility and impact on the stock would likely
ascertain the final decision10.
Another interesting interpretation taken by SEBI
for the term “substantial” was in a
case where the impending order was said to be considerable
when it comprised of at least 3% (Three Percent)
of the total traded stock of such scrip and if the
order size was equal to or greater than 4,000 (Four
Thousand) shares11.
The SEBI (Prohibition of Insider Trading) Regulations,
201512, which contain SEBI's insider
trading regulations, are also relevant. Trading
based on price-sensitive information that is not
released is expressly prohibited under these restrictions.
Leveraging such information for high frequency trading
(HFT) front-running purposes could violate these
rules and result in SEBI enforcement action.13
The applicable penalty in case of front running
may be found under Section 15-HA along with Section
24 of the SEBI Act which provide for a penalty not
less than INR 5,00,000 (Indian Rupees Five Lakhs)
(approximately USD 5,734) which may extend up to
INR 25,00,00,000 (Indian Rupees Twenty-Five Crores)
(approximately USD 28,67,000), or 3 (three)
times the amount of profits made out of such practices,
whichever is higher. Section 24 specifically allows
for a criminal proceeding to be initiated in case
of a contravention, along with the imposition of
a penalty. The jurisprudential nature of such cases
allows for a civil and criminal penalty to be invoked
together.14
Invocation of a criminal proceeding under Section
24 of the SEBI Act was clarified in the case of
Prakash Gupta vs. SEBI15 where
it was stated that the provision is an omnibus provision
and can be used against “most banal of
offences, to the most egregious of market disruptions
and frauds”. This provides a clarification
that the provision can be used in case of front
running cases as well.
Recently, SEBI uncovered a front-running scheme
involving former stockbroker Ketan Parekh and 21
(twenty-one) associates. The scheme involved using
non-public information about large trades planned
by a significant client managing USD 2.7 trillion
in assets. SEBI uncovered this scheme through meticulous
analysis of communication data, including mobile
phone records. Notably, a mobile number registered
to Ketan Parekh's wife played a crucial role in
linking him to the fraudulent activities.16
SEBI’s investigation, covering the period
from January 1, 2021, to June 20, 2023, prima
facie indicated that Ketan Parekh and his associates
employed complex trading strategies to exploit their
prior knowledge of the client’s impending
trades. As a result, SEBI issued an interim order
barring Ketan Parekh and two others from dealing
in securities for an unspecified period and initiated
proceedings to recover the illicit gains17.
Risk Mitigation
Regulatory bodies in India, such as the SEBI,
have regulations and measures in place to prevent
and penalize front running activities to maintain
transparency and trust in the securities markets.
Front-running gives a select few an unfair advantage,
manipulates stock prices, and impairs trust in financial
markets. Recently, on April 30, 2024, SEBI has proposed
amendments18 to the SEBI (Mutual Funds)
Regulations, 199619 in order to establish
an institutional mechanism which would aid in preventing
front running as well as other activities in such
regard (“2024 Amendment”).
SEBI stated that the mechanism shall consist of
enhanced surveillance systems, internal control
procedures and escalation processes to identify,
monitor and address specific types of misconduct
including front running, insider trading and misuse
of sensitive information.20
In the present-day mechanism, the trustees of
the mutual funds are required to provide a declaration
through the periodical reports to SEBI that the
mutual fund has not witnessed any instances of self-dealing
or front running by the directors, key managerial
personnel as well as the employees. Further, under
the Code of Conduct for Asset Management Companies
and Fund Managers and Dealers21 (“FMDs”),
practices such as circular trading, artificial inflation
of trading volumes, simultaneous buying and selling
of the same securities at off market prices in order
to create false or misleading signals, manipulation
of prices of infrequently traded securities etc.
have been expressly prohibited. While this mechanism
imposes several restrictions and checks on the mutual
funds, there is no specific requirement under it
to establish a structural and institutional framework
/ committee for prevention and strict prohibition
on market manipulation, including front running.
There is also no requirement to have in place a
whistleblower policy or a vigil mechanism.
Accordingly, SEBI proposes to make amendments
to SEBI (Mutual Funds) Regulations, 1996 keeping
in mind the gaps in the existing framework to prevent
market malpractices, including front running. These
amendments, although yet to be notified, include
the requirement to put in place an institutional
mechanism which is structured in order to identify
and prevent any market abuse, enhancing the responsibilities
of the asset management companies in cases of market
abuse, setting up of a whistleblower policy for
risk mitigation as well as a relaxation of the erstwhile
norms which required the FMDs to record all communications
during market hours.
Authors
-
Khyati Dalal
and
Palomita Sharma
You can direct your queries or comments
to the relevant member.
1Available at
https://dictionary.cambridge.org/dictionary/english/front-running
2Available at
https://www.sebi.gov.in/legal/circulars/may-2012/amendment-to-the-consent-circular-dated-20th-april-2007_22808.html
3SEBI (Settlement of Administrative
and Civil Proceedings) Regulations, 2014 Reg 5(2)
4Available at
https://www.sebi.gov.in/legal/regulations/jun-2024/sebi-prohibition-of-fraudulent-and-unfair-trade-practices-relating-to-securities-market-regulations-2003-last-amended-on-june-28-2024-_84781.html
5 SEBI Order in the matter of Front
Running by Mr. Mandar Ulhas Bhatkar, January 29,
2025, available at
https://www.msei.in/SX-Content/Circulars/2025/January/Circular-16683.pdf
6Regulation 2(1)(d) of SEBI (Prohibition
of Insider Trading) Regulations, 2015
7Regulation 2(1)(n) of SEBI (Prohibition
of Insider Trading) Regulations, 2015
8SEBI vs. Kanaiyalal Baldevbhai Patel,
(2018) 207 Comp Cas 416 (SC)
9In the matter of Front Running Trading
activity of Dealers of Reliance Securities Ltd.
and other connected entities, available at
https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/jan-2023/1675081215253_1.pdf
10In the matter of front running of
orders of Quest Investment Advisors Private Limited
by Ketan Bhupendra Parekh and Bhupendra Jasvantrai
Parekh, available at
https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/feb-2023/1676031603443_1.pdf
11In the matter of Front Running by
Banhem Securities Pvt. Ltd. and Ninja Securities
Pvt. Ltd., available at
https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/mar-2023/1680004209712_6.pdf
12Available at
https://www.sebi.gov.in/legal/regulations/nov-2022/securities-and-exchange-board-of-india-prohibition-of-insider-trading-regulations-2015-last-amended-on-november-24-2022_65864.html
13SEBI (Prohibition of Insider Trading)
Regulations, 2015, Reg. 3(1), "No insider shall
communicate, provide, or allow access to any unpublished
price sensitive information, relating to a company
or securities listed or proposed to be listed, to
any person including other insiders except where
such communication is in furtherance of legitimate
purposes, performance of duties or discharge of
legal obligations."
14Securities and Exchange Board of
India vs. Cabot International Capital Corporation,
2004 SCC OnLine Bom 180.
15Prakash Gupta vs. Securities and
Exchange Board of India, 2021 SCC OnLine SC 485.
16Available at
https://economictimes.indiatimes.com/news/india/how-ketan-parekhs-wifes-phone-helped-sebi-uncover-a-rs-65-crore-front-running-scam/articleshow/116920346.cms
17In The Matter of Extended Front
Running by Rohit Salgaocar, Ketan Parekh and Others,
available at
https://www.sebi.gov.in/sebi_data/attachdocs/dec-2024/Front_Running_Order_Big_Client.pdf
18Available at
https://www.sebi.gov.in/sebi_data/meetingfiles/may-2024/1715144023897_1.pdf
19Available at
https://www.sebi.gov.in/legal/regulations/aug-2023/securities-and-exchange-board-of-india-mutual-funds-regulations-1996-last-amended-on-august-18-2023-_76333.html
20Available at
https://www.thehindu.com/business/sebi-board-approves-amendment-to-mf-rules/article68125619.ece
21Available at
https://www.sebi.gov.in/sebi_data/meetingfiles/oct-2020/1602839577069_1.pdf
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